Many people spend the pre-retirement years focused on saving as much as possible, often in tax-deferred accounts like 401(k)s, IRAs, and HSAs, where pre-tax contributions give them an immediate tax break. Less time is usually spent planning for the tax bill that will come due later.
It’s common to use a combination of Social Security benefits, traditional and Roth IRA savings, HSAs, and taxable accounts to fund retirement. Tapping into these accounts to pay for expenses takes some expertise to manage the tax burden in each year of retirement. Making strategic choices can, for example, mean the difference between paying Medicare surcharges (IRMAA) and/or penalties on retirement account withdrawals.
As you approach retirement, it’s time to put a tax plan in place for the potentially low-income period you may experience between retiring and starting withdrawals from tax-deferred accounts. This so-called “income valley” can present a valuable opportunity for retirees to smooth out tax spikes that tend to hit later.
Why are taxes critical as you transition to retirement?
Retirement planning is a big puzzle, where tax considerations and account withdrawal rules play significant roles. Two critical components to tax-efficient planning are:
- Your retirement date
- The date you need to begin withdrawals, or RMDs, from tax-deferred accounts
Learn more about when your RMDs must begin in Viewpoints: How do I calculate my required minimum distribution?
What is the retirement income valley and why does it matter?
The period after retirement (starting in the year of retirement) may be an “income valley.” This is a period when your earned income is either $0 or much lower than when you worked full-time, and other income from Social Security, a pension, and/or retirement plan accounts either hasn’t started yet or is still lower than what your total income will be in future years. This income valley creates special opportunities for tax planning.
The duration of the income valley can vary from person to person. It depends in large part on when you retire, start pensions, claim Social Security, engage in a part-time job, and withdraw from tax-deferred accounts.
The Social Security full retirement age for most working Americans today is 67. That’s the age at which you can begin collecting your full monthly benefit, based on a formula that takes into account your career earnings. If you claim benefits between age 62 and 66, your monthly check is permanently reduced. If you delay claiming until age 70, your benefit increases by about 8% per year (on top of inflation), resulting in a higher monthly check for the rest of your life. For many healthy retirees with sufficient retirement savings, it’s optimal to delay until age 70 for a higher lifetime payout.
Example of the retirement income valley
Let’s look at a hypothetical single retiree, John, who turned 67 on February 26 of the current year. John then retired from his job as an engineer in March, but plans to delay claiming Social Security until 70. John will receive only 2 months of his annual salary this year, which gives him room to bring a portion of his future income into the current year without experiencing a tax bill spike.
The first 3 years, he can live off withdrawals from a $150,000 checking account plus withdrawals from a taxable brokerage account. While cash withdrawals from a bank account are not taxable, sales in the brokerage account are subject to capital gains tax rates. In John’s case, he will pay 0% federal tax on capital gains up to $49,450 (after the amount of his deductions), since his only other income is from a bank account. John is experiencing the income valley.
But the income valley won’t last forever. When John turns age 70, he begins collecting Social Security benefits, and when he turns age 73 he’ll have to start RMDs from his tax-deferred accounts, whether he needs the funds or not. Together, along with any income and realized gains from his investments, this additional income will eventually push him into a higher marginal tax bracket.
Those years with lower taxable income present a valuable window of opportunity for tax planning. If John makes use of the income valley to shift some of the expected RMD income to earlier years, especially before collecting Social Security, he has the opportunity to smooth out his tax bill over time.
Tax strategies for pre- and early retirement years
Rather than staying in lower marginal tax brackets during the income valley and potentially shooting up to higher marginal tax brackets once he has to start taking money from tax-deferred accounts (either because he has run out of taxable and tax-free accounts or has to start taking RMDs), John can take steps to smooth out his tax bill over time. Starting in the year he retires, he can withdraw from tax-deferred accounts, do Roth conversions, and/or harvest long-term capital gains to “fill up” those lower tax brackets during the income valley in several ways. Strategies include:
Shift final pre-retirement savings to Roth. If you’re planning to retire part-way through the year, like our hypothetical retiree John, consider switching from traditional to Roth 401(k) contributions at the beginning of the year, if your company allows them. With less income to report the year you retire, you may not need the immediate tax break from a 401(k) contribution, and paying the taxes on these contributions upfront in a lower income year than you anticipate in future may result in tax savings later on. The year you retire is likely your last opportunity to contribute to a retirement plan, so contributing as much as you are comfortable with may be to your benefit. Of course, to do this you may have to set your contribution rate to 20%, 30%, 40% or more in your year of retirement.
Plan for Roth conversions. One of the most powerful strategies is a partial or full Roth conversion. John could convert assets from his pre-tax 401(k) or traditional IRA every year before RMDs kick in to fill up the 22% marginal tax bracket, which tops out at $105,700 for single filers and $211,400 for married joint filers in 2026, or the 24% marginal tax bracket, which tops out at $201,775 for single filers and $403,550 for married joint filers in 2026.
Converting the pretax funds to a Roth removes them from the eventual RMD calculation, meaning the amount John’s forced to withdraw and pay taxes on later decreases. By bringing the distributions into a year when his income is temporarily low (remember, he’s living off of cash and investment income from his taxable accounts in the first 3 years of retirement), he is able to pay the taxes now, at a more predictable, and likely lower, rate than in the future. John anticipates that his retirement year may be the lowest income year he will have for the rest of his life, so implementing a thoughtful Roth conversion strategy with the help of his financial planner and tax professional may benefit him in the long run.
Qualified withdrawals from a Roth account are tax- and penalty-free when you are 59½ or older and the 5-year rule for the Roth IRA has been met, so those withdrawals would not affect John’s tax liability when he decides to take them later. Or, if he doesn’t need the income, he could leave the account income tax-free to his heirs.1,2
Consider withdrawals from tax-deferred accounts. While John is primarily living off cash and investment income from taxable accounts early in retirement, he could also use the low-tax years of the income valley to begin withdrawing money from tax-deferred accounts, which could have the dual impact of reducing RMDs and smoothing out a potentially higher tax bill later in retirement.
Delay Social Security. As discussed earlier, John can stretch his income valley by waiting to claim Social Security until he’s 70, despite retiring at age 67. In the year he retires, he only gets 2 months of salary income. By delaying Social Security until age 70, instead of claiming in March of the current year when he turns age 67, he helps create an income valley. Since his only other income before collecting Social Security is non-taxable or taxed at very low rates, he has the ability to convert a significant portion of his pretax funds at lower tax rates. When Social Security benefits begin, he may need to pull back on conversions if he wants to keep his tax bill level.
Manage work-related income. The year leading up to retirement is consequential when it comes to tax planning. Considerations include the timing of bonuses, restricted stock units (RSUs), severance, nonqualified deferred compensation (NQDC) plans, and pension plan beginning dates. For example, the date you retire may well determine when you receive your payout. A difference of a single day may delay your payouts by up to a year, so keep this in mind when making your elections.
Review your company policies and key dates at least a year before you plan to retire, so you don’t miss any deadlines or trigger unintended penalties. If you have a pension, learn more about how to make the most of it and how your pension income may be taxed.
Consider tax-gain harvesting. Another tax strategy that may become available in the year of retirement is tax-gain harvesting (TGH). Tax-gain harvesting is the opposite of tax-loss harvesting (TLH), and sometimes even better. TGH eliminates a tax liability, while TLH only defers a tax liability. Essentially, TGH involves realizing just enough long-term capital gains in a taxable account to fill up the 0% capital gains tax bracket, which for a married couple filing jointly means a taxable income (after all deductions) up to $98,900 for the 2026 tax year.
Watch out for key income thresholds
There can be limitations to bringing future income into the income valley. Increasing your income too much during these years could disqualify you for certain tax breaks or make yourself vulnerable to additional taxes or surcharges based on your income level. These include:
- IRMAA (Medicare Income-Related Monthly Adjustment Amount): Medicare recipients with annual modified adjusted gross income (MAGI) greater than a specified amount for their tax filing status pay a surcharge on Part B (Medical Coverage) and Part D (Drug Coverage) of their Medicare premiums. The surcharge is generally calculated based on the MAGI reported on the recipient’s tax return from 2 years prior.
Learn more about when IRMAA may apply, and circumstances in which you may be able to appeal an IRMAA decision in Viewpoints: Will your retirement income impact Medicare surcharges?
- Premium tax credit: If you retire before age 65, when Medicare kicks in, you may need to keep an eye on your eligibility for the premium tax credit, a subsidy offered to households with incomes between 100% and 400% of the federal poverty line who pay for marketplace health insurance. Managing your MAGI during your income valley to fall in this range may result in substantial subsidies to your health insurance premiums before you are eligible for Medicare. Note that if you qualify for Medicaid in your state, you will not be eligible for the premium tax credit, even if your income falls between 100% and 400% of the federal poverty limit.
Since John is retiring at age 67, he will go directly onto Medicare from his employer's health insurance and, thus, will not enroll in a marketplace plan and not qualify for the premium tax credit.
- Social Security taxation: Social Security income typically isn’t enough to lift someone out of the income valley on its own, but the presence of other income, such as Roth conversions or investment income from taxable brokerage accounts, in the same year can result in taxation of Social Security. Up to 85% of your Social Security benefits may be taxable in any given year. Waiting an extra year, or years, to claim Social Security can increase the length of time you are in the income valley by reducing your income and could potentially increase your benefit in future years.
Find out more in Viewpoints: Should you take Social Security at 62?
- Senior tax deduction: From tax years 2025 to 2028, individuals age 65 and older can claim a new $6,000 senior tax deduction. Eligibility phases out when an individual’s MAGI reaches $75,000. For a couple filing jointly, the threshold is $150,000.
In our example, John might want to weigh his income options carefully as he transitions into retirement. If he worked further into the year, decided to make a substantial Roth conversion, or began claiming Social Security in the year of his retirement, he might inadvertently reduce his senior deduction by pushing his MAGI over $75,000. By consulting with a tax or financial professional, he could potentially create a financial plan that weighs each of these options.
- Net investment income tax: The net investment income tax, or NIIT, is another important threshold to be aware of to avoid additional taxation to the extent possible. It applies to married-filing-jointly households with MAGI over $250,000 or single filers with MAGI over $200,000. Exceeding that threshold would increase the marginal taxation of your investment income (including dividends, interest, capital gains, rental income, etc.) by 3.8%. The income limits are not indexed for inflation.
The bottom line on taxes in retirement
It may not be possible to take advantage of all the strategies mentioned above at once, but it is critical to weigh longer-term moves with shorter-term ones, especially when decisions may cause them to compete. Consider working with a financial professional who can help you navigate key decisions.
While reducing the impact of taxes on your retirement income can be a primary goal during the income valley, it should be considered in conjunction with lifestyle and legacy goals. A financial professional can also model out various strategies for the income valley to determine the best approach for your situation.